Global Tax Alert. Spain proposes amendments to the Spanish ETVE and participation exemption regimes. Executive summary. Detailed discussion

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1 12 September 2014 EY Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date Spain proposes amendments to the Spanish ETVE and participation exemption regimes Executive summary The Spanish Government recently introduced a bill amending the Spanish Corporate Income Tax Law in the Spanish Parliament. This bill, which will be discussed in the following months and which if passed will apply as from 1 January 2015, proposes certain changes to be made in the Spanish holding companies (ETVE) regime and revises certain aspects from an earlier proposal. 1 The draft bill also contains substantial amendments to the Spanish participation exemption regime, on which the ETVE regime relies. These amendments intend to introduce more flexibility in the Spanish regime applicable to the holding of foreign subsidiaries as well as to align it with the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) project. Detailed discussion The proposed new ETVE regime relies fully on the general participation exemption rules, for purposes of calculating exempt income and gains. The only specificity of the ETVE regime will be the treatment of its shareholders who will also be exempt from Spanish taxation on dividend income and/or capital gains derived from the ETVE when ultimately stemming from the participation in foreign subsidiaries of the ETVE which comply with the Spanish participation exemption requirements.

2 The draft bill introduces the following amendments to both the ETVE and the participation exemption regimes: The minimum cost of acquisition of the shareholding for the participation exemption regime to apply is increased from 6 million to 20 million and is available to all Spanish companies, and not only to those benefitting from the ETVE regime. This threshold offers an alternative to the minimum 5% ownership requirement which, together with the minimum one-year holding period requirement, continues to apply. The so-called business activity test, which currently requires that at least 85% of the foreign subsidiary s total revenues derive from the conduct of a business activity carried out outside of the Spanish territory, has been eliminated. This requirement has proved to be the most burdensome of those included in the Spanish participation exemption regime and, consequently, its elimination results in a significant simplification of the regime. By the same token, the possibility to cleanse income from nonqualifying subsidiaries by means of controlled dividend distributions is eliminated. Under the proposed amendments, dividends received by the Spanish holding company will have to be tracked to determine whether they qualify for the application of the participation exemption regime, depending on their source. A new subject-to-tax test is introduced, under which foreign subsidiaries must be taxed at a minimum nominal rate of 10% for the exemption to be available. The bill clarifies that in order to determine whether this test is complied with, bonifications or similar tax benefits which may be applicable to the income obtained by the foreign subsidiary may be disregarded. Under the proposed bill, tax treaty resident subsidiaries continue to be deemed to automatically comply with this test. Also, income and gains from tax haven entities continue to be precluded from the application of the participation exemption regime, regardless of the nominal tax rate at which they are taxed. The draft bill makes the application of the participation exemption to capital gains arising from the transfer of shares in certain foreign subsidiaries dependent on compliance with (amended) CFC rules. Under these rules, the foreign subsidiaries are required to have a minimum level of substance. In line with the OECD BEPS project, the exemption is denied to dividend payments which have been treated as tax deductible by the foreign payer (but so long as the yield is not deductible by the debtor, interest on intra-group profit sharing loans will now qualify for the exemption), as well as to other dividends which, under stock lending and other derivatives arrangements entered into by the Spanish recipient with a third party, cause the Spanish company to register deductible interest (but where such third party may be eligible to the exemption, under certain circumstances). Also to be noted, the Spanish CFC regime itself will expectedly be amended. Under the proposed changes, a larger number of situations where low-taxed, passive income is generated within an international structure (whether under an ETVE or under other Spanish corporate taxpayer) and which are currently outside the reach of the regime will be potentially affected by the rules of inclusion. Finally, there are other proposed measures within the draft bill that can also affect ETVE and other through-bound structures in Spain, such as, for instance: Modification of the anti-abuse rule applicable to the eligibility for the withholding tax exemption on dividend distributions made by Spanish entities to their EU parent companies, where the EU recipient is majority-controlled by a non-eu shareholder. Share premium distributions may be subject to withholding tax, instead of reduce basis in the shares of the distributing entities, when at the time of the distribution there are retained earnings in the distributing entity. An improved credit (where exemption does not, or is chosen not to, apply) system to avoid international double taxation. 2

3 Implications ETVE and other Spanish international structures may need to be reviewed in order to confirm that the participation exemption regime continues to apply (on dividends and on capital gains, whether in the case of a simple transfer of shares, or in the case of corporate restructurings or unwinding) under the proposed amendments, and that the new CFC rules will not generate imputable income in Spain, taxed at ordinary corporate income tax rates. Also, some existing structures which have tainted income under current rules may well be favored by the new proposed rules, if and when approved. Performing this analysis before the new rules enter into force may allow international groups to mitigate any adverse tax consequences arising from these amendments, if any, and to restructure, if needed. Future Alerts will cover legislative developments with respect to this bill. Endnote 1. For background on this topic, see EY, Spanish Government proposes amendments to the ETVE and participation exemption regimes, dated 24 July

4 For additional information with respect to this Alert, please contact the following: Ernst & Young Abogados, Madrid José Luis Gonzalo Ernst & Young LLP (United Kingdom), London José Antonio Bustos Ernst & Young LLP, Spanish Tax Desk, New York Cristina de la Haba

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